Earnings Surprises, Growth Expectations, and Stock Returns:

Table 1 provides descriptive evidence on our first two predictions. Recall from
Figure 2 (b) that these predictions require that all of the MB return differential is
concentrated in the negative earnings surprise portfolios. The evidence in Table 1 shows
this to be the case. The mean abnormal returns for the zero and positive surprise
portfolios show no systematic trend as a function of growth. If anything, the high growth
portfolio returns actually seem to be slightly higher than the low growth portfolio returns,
opposite to what is necessary to explain the overall value vs. growth effect. However, the
negative surprise portfolios tell a different story. The mean abnormal returns decline
monotonically across growth portfolios from a high of –3.57% for portfolio 1 to a low of
–7.32% for portfolio 5. The pattern of returns clearly coincides with the asymmetric
response to negative surprises depicted in figure 2 (b), rather than with the unrelated
effects depicted in figure 2 (a). This pattern indicates that the predictable lower returns
for high MB firms are realized when these firms subsequently report negative earnings
surprises.
There is one problem with our comparisons between the predicted results depicted
in figure 2 (b) and the results that we report in table 1. Figure 2 (b) holds the proportion
of securities in the positive and negative surprise portfolios at 50% each. However, in
table 1, the relative proportions are not constant. Table 1 includes the ‘Zero’ portfolio,
and the proportion of firms that fall into the ‘Zero’ portfolio increases as we move up the
growth portfolios. The reason for the changing proportions is not clear. One possibility
is that managers of growth firms try harder to manage earnings to meet analysts’
expectations, perhaps because they are aware of the large stock price penalty that could
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